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When you’re looking to buy or sell your practice, you’ll often find the term “cost of capital” buried in a valuation. Let’s demystify this concept along with other related terms. Cost of Capital (often abbreviated CoC) is a term often found in dental practice valuations formulas and is often denoted as r. This r is used because CoC plays the more general role of required rate of return in those formulas. Here’s the simplest form of these formulas: … In this context, required return (and thus CoC) expresses the financial return prospective buyers of a practice expect to receive. The way CoC does this is by discounting the future income expected from a practice to arrive at its valuation. Because CoC discounts future income in this way, yet another similar term, discount rate, is often used to refer to the same concept as CoC. When a practice has debt holders (for example, a bank when it finances a practice), additional terms will be used because debt holders and practice owners have dif

So what’s better for practice valuation: a higher or lower Cost of Capital? Generally speaking: … Alternative availability tends to be an external factor dental practices cannot control except when buying a practice or setting up a new practice. For this reason, it’s important to factor in and anticipate alternatives by assessing the number of dentists per person in your area. – By understanding the factors behind Cost of Capital, you can better justify a deviation from industry averages. Let us help you get your best deal by reading Negotiating Practice value with Cost of Capital.

Once you’ve understood the term Cost of Capital, you can use it to derive or justify a valuation for a dental practice. Let’s work through an example. Let’s say your practice brought in $200,000 of Net Income (NI) this year and is expected to bring in a similar NI next year. You just received an offer for $2,500,000 and will sell your practice debt free with the buyer being responsible for their own financing. Should you take the offer? Reviewing our list of valuation formulas, we are best off using the perpetuity valuation formula since our NI is not expected to change: … Opening using this justification, we can reasonably justify a higher price around $2,750,000 for the dental practice. That said, there may be particulars about location, patient pool, or more that could further justify downward deviation from such price, but you can leave it to you prospective buyer to build such case. Remember, great negotiation starts with clear communication between a buyer and seller. By using be

By definition, a sunk cost is any cost you’ve made in the past. Problems with sunk costs arise when you have to make new plans, and they can easily get in the way of your best interests. For example, let’s say you recently bought an existing dental practice in a small town. The patient pool was great on day one, but about a month later, the town’s largest employer announced plans to relocate. It’s been a year since then, and as the town’s jobs have moved, so have the majority of your patients. What now? Whatever your choice, if the time and money you’ve already invested influences your decision, then sunk costs have unfortunately muddled your thinking. Fascinatingly, this not so contrived example was put to the test in 1993 by two Stanford professors, who, using ADA data, found that dentists often fell victim to sunk costs, especially dentists with local monopolies. Remember, that as a business person planning ahead, it’s critical to stay focused on the full breadth of your future oppo